IEEJ：August 2015

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Special Bulletin
A Japanese Perspective on the International Energy Landscape (232)

August 14, 2015

Yuan Devaluation Shaking World Economy and Oil MarketKen Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, Japan
On August 13, the benchmark West Texas Intermediate crude oil futures price (the dailyclosing price for the front-month contract) fell by $1.07 per barrel from the previous day to thisyear's new low of $42.33/bbl, slipping below the year's previous low of $43.46/bbl posted on March
17 after a plunge since late last year. The intraday low for August 13 stood at $41.91/bbl, close to thepsychologically important barrier of $40/bbl.
The WTI price bottomed out after the low in March and stayed in a $50-60/bbl range in
April and a $50-70/bbl range in May and June. Its high for this year was $61.43/bbl on June 10.
From the high, the August 13 level represented a sharp fall of some $19/bbl or 31%. The WTI pricegradually declined from July and hit this year's new low on August 13, indicating a double dip
situation. Future developments are difficult to predict.
As noted in my previous special bulletin on “A Japanese Perspective on the International
Energy Landscape,” multiple factors have been behind the crude oil downslide since July. The firstfactor is a basic oversupply. The second is a downside risk fear for Greek, Chinese and othereconomies. Coming third is a high oil production level maintained by the Organization of thePetroleum Exporting Countries. The fourth factor is the presence of shale oil production indicating astrong resistance to low oil prices. The fifth is Iranian crude oil's expected comeback to theinternational oil market after Western countries' future termination of sanctions on Iran. Among otherfactors may be financial ones like the dollar's strength and an expected U.S. interest rate hike, as
well as a risk-off situation emerging from the destabilization of the Shanghai stock market.
But there is a new factor among those behind the latest fall to this year's new low. That is
China's decision to devalue the yuan, which surprised market participants.
Among Chinese factors, the economic growth deceleration and the plunge anddestabilization on the Shanghai stock market had played a role in pushing down oil prices earlier, asexplained above. The economic growth and Shanghai stock market factors had already been
discounted into the market in the absence of no major changes regarding these factors. But thePeople's Bank of China announced a decision on August 11 to lower the target value of the yuan
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against the U.S. dollar by 2% from the previous day, astonishing market players throughout theworld.
The yuan devaluation continued for three days until August 13, bringing the totaldevaluation to 4.5%. (On August 14, the Chinese central bank raised the target value by 0.05% fromthe previous day, indicating an end to the yuan devaluation for the immediate future.)
The Chinese authorities described the yuan devaluation as the first phase of a foreignexchange market reform to make even the controlled yuan value close to the market’s prevailinglevel by raising or lowering the target closer to the previous day's closing market rate. On August 14,
the Chinese central bank raised the target by 0.05% to end the yuan devaluation campaign for theimmediate future, allowing the market to take a breather. The lingering key problem is how theChinese authorities would move the target value for the yuan in response to future market
developments.
A key reason the yuan devaluation campaign shocked the market is that many market
players interpreted the campaign as being designed to stimulate China's exports and its economy andgrew confident that Chinese economic conditions have deteriorated to such an extent. Direct market
intervention to devalue a currency can eventually lead to an international currency-devaluing race toshake the world economy. For China that is the second largest economy in the world, such a measure
is a risky one that could expose the country to severe denunciation by its major trading partners.
Market players speculate that if the authorities implemented the measure while acknowledging such
result, it may indicate that economic conditions have worsened to the extent where some action must
be taken.
As noted above, the Chinese authorities have explained the yuan devaluation as part of amarket reform rather than as a measure to stimulate exports. But many market players do not seem tobe convinced by the explanation. The successive yuan devaluation has led to a global stock market
decline to destabilize the world economy. The currency devaluation has prompted some people toanticipate a capital flight from China. Given the international criticism and serious adverse effects,
some market players suspect a pause in the yuan devaluation campaign.
But the problem is the great significance of the Chinese economy for the world. If China's
real economic conditions are worse than conceived at present, it may have great impacts on countries
for which China is a key economic, trading partner. The United States, Europe (including Germany),
Japan and other major Asian countries cannot brush off the problem, which also has great impacts on
resource-rich countries that depend heavily on China's demand and import expansion.
The Greek debt problem and the Shanghai stock market plunge since July had alreadymade market players in the world nervous before the yuan devaluation problem emerged as a new2

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major destabilizing factor. As a matter of course, the yuan devaluation, if not substantial, may
contribute to stimulating the Chinese economy to the advantage of the world economy. In this sense,
the situation is not simple. We may have to carefully watch Chinese economic conditions, marketand policy trends and their impacts in the future.
The yuan devaluation has emerged as a new component of the so-called China risk,
shaking the world economy and affecting crude oil prices. For the double-dip oil market, Chinese
economic developments may remain the largest uncertain factor.

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